Jun 15, 2012
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Merchant Cash Advances as Alternative Business Funding

One of the hardest hit markets in the credit crunch of recent years has been the small and medium business owner. Many small and medium businesses have found that they simply cannot get approved for any kind of lending from their banks, and this is causing their businesses real, and in some cases fatal, funding difficulties. As more and more business are hit with drying lines of credit, merchant cash advances are becoming increasingly popular. An alternative to a bank loan, merchant cash advances can be more easily attained for businesses in certain markets – namely ones that process high numbers of transactions through debit/credit card payments. Merchant cash advances are not deemed to be loans, and as such are not regulated as loans, so businesses need to be wary before entering in to any agreements. That being said, many business owners are finding that desperate times call for desperate measures, and the merchant cash advance industry is flourishing. So what exactly is a merchant cash advance?

What is a Merchant Cash Advance?

Very simply, a merchant cash advance is an up-front lump sum payment in exchange for a percentage of future sales processed by debit or credit card. A small business, for example a family restaurant, may find that they have cash flow issues and cannot get any lending from their bank or credit institution. They approach a merchant cash advance company that agrees to give them a lump sum, let’s say $10,000. In return, the restaurant agrees that a percentage of all credit or debit card payments go straight to the cash advance company until they have paid an agreed amount, e.g. $12500. Depending on the agreement and level of turnover, the percentage per payment could be as low as 1-2% or as high as 20 – 25%. In most instances, the payment is arranged so that the card processing company splits the transaction amount between the retailer and the cash advance company. Once an agreed repayment amount is reached, the retailer reverts to receiving the full proceeds of their card payments.

What are the Benefits of a Merchant Cash Advance?

Merchant cash advances can be extremely beneficial for small companies. If a business cannot get a small business loan, or is informed that they have a poor credit history, then standard lending is not feasible. A cash advance company is more concerned about the processing volume of card transactions than they are with credit history. The small business benefits from access to cash, and from the absence of a fixed term repayment contract. If they have a particularly slow month, their repayments to the cash advance company are in turn proportionally lower, meaning there is far less of a burden for seasonal businesses. Similarly, the application process is often far simpler and less time consuming to complete. For the cash advance company, the greatest risk involves the company going under before the amount has been repaid. Depending on the risk of this happening, the amount requested, and effective “cost of credit”, will vary between applicants. Unlike a standard small business loan, the cash advance company does not have to worry about the business not meeting set repayments as they will receive a percentage on even the quietest days.

What are the Drawbacks of a Merchant Cash Advance?

Merchant cash advances are considered sales and not loans – i.e. the cash advance company is buying a set amount of future sales. This means that the typical usury laws – that is the laws governing what percentage can be charged on amounts forwarded – do not apply. As a result, merchant cash advance companies can charge fees that would be quite in excess of that of a comparable bank loan. Similarly, because the cash advance is not deemed to be a loan, it is not deemed to be discharged under bankruptcy proceedings. This means that a business owner or business that has been declared bankrupt can still be legally pursued for any outstanding debt in respect of a merchant cash advance. The cash advance company also faces potential inflation losses. If a company’s trade is considerably slower than predicted, it may take far longer than anticipated for the cash advance to be repaid, and this could impact on the net profit for the cash advance company.

Are Merchant Cash Advances a Viable Source of Funding?

Not only are they a viable source of funding, but for many small businesses and start-up companies they are the only source of funding available. Merchant cash advances are a very real and legitimate method of accessing lines of credit when options are limited. The problem is that there is little to no authoritative regulation in place to govern this type of funding. As a result, cash advance companies can draw up complicated and restrictive contracts heavily weighted in their favor, and the retailer has little protection in the event of any dispute. There are a core group of experienced cash advance companies that specialize in merchant cash advances, and they take great pride in their business. However, there are just as many unscrupulous companies that are simply trying to cash in on an increasingly popular financial product. Anyone looking to avail of a merchant cash advance should take the time to research the company they enter into agreement with, and should also have the agreement read over by their solicitor before signing anything.

Merchant cash advances can be extremely beneficial to both parties if used appropriately, and as more customers go cashless, more companies will see the benefit of providing cash advances. While some stricter regulation on the matter would be welcome, businesses can still protect themselves by only entering into an agreement that they have carefully researched and understood.

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